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Wednesday, September 26, 2012

Some problems cannot be solved, they must be managed: a case against taxpayer subsidized amenities

2006: State of MN promises $393 million in public subsidy
2007: State promises 138.48 million for the new TCF Gopher’s stadium
2012: Vikings awarded $1 billion for a new stadium
2012: Saint Paul Saint’s promised $25 million to move the stadium from it’s current location in Midway to Lowertown

This semester I’m taking a class with former research director at the Federal Reserve Bank of Minneapolis, Art Rolnick. Dr. Rolnick is also a Senior Fellow at the University of MN’s Humphrey School of Public Policy and one of the leading experts in the economics of investing in early childhood education. I’m fortunate enough to listen to his insights on investing in early childhood development twice a week, and I wanted to take a minute to share some of his views with my readers.

Before taking this class, I was a big supporter of a Lowertown Ball Park. I live a few blocks away and I believe the stadium will generate a lot of revenue within the city of Saint Paul. I think it will be a cherished amenity, and I’d even go as far as calling it a public good for the city.

But Dr. Rolnick has convinced me that these stadiums represent a serious problem for the overall economy. He often uses stadiums as an example simply because budget deals for stadiums are so highly publicized. The unfortunate reality is, states are offering subsidies to expand and retain private businesses all the time. 

Retaining and “attracting” businesses makes sense at the state level, but it makes no sense for the national economy. If a company has a greater comparative advantage with headquarters in Atlanta, GA, then it would be in the best interest of the national economy for that company to base its headquarters there.

However, that is not how the scenario is typically played out. Competition for businesses among the states is a zero-sum game, or even a negative-sum game, in which private businesses are the benefactor and taxpayers are the losers.

The root of this problem is that cities and states competing for businesses cannot afford to ignore one another. For example, if MN had decided not to participate in competitive behavior, the Vikings would have left for LA; they in fact, used that very argument to put pressure on the state. Herein lies the problem, while it is rational for individual states to compete for specific businesses, the overall economy is worse off from their efforts because taxpayers lose important tax revenue to support public goods, such as funding for education, and businesses suffer because subsidies encourage a misallocation of resources.  

Some people have another word for the act of forcing somebody to pay for something by threatening to do something harmful to him/or, and that word is blackmail. The problem is, the rules of the game are set up to encourage this type of behavior. I don’t blame private businesses or states for participating in this game, because the incentives of the game encourage participation.

Understanding this issue can be clearly illustrated using game theory. The matrix for this game is presented in the following chart. Imagine the figures in the boxes represent the amount of revenue (in millions of dollars) each state has to win or lose by choosing to cooperate or compete.

California
Minnesota

Cooperate
Compete

Cooperate
(5, 5)
(-2.5, 7.5)


Compete
(7.5, -2.5)
(-2.5, -2.5)



The two strategies available to each state are (1) to cooperate by refusing to participate in competitive behavior with other states, or (2) to compete with the other state by offering subsidies and tax incentives for businesses to relocate to their state.

What should these states do? Consider first California. If Minnesota cooperates (doesn’t offer a subsidy to build a new stadium), the best thing  for California to do is compete. California would enjoy additional tax revenue from the Vikings relocating from Minnesota to California.  However, if Minnesota competes (offers the subsidy), again the best option for California to do is to compete (offer an even greater subsidy) because failing to compete would result in a substantial loss in tax revenue.

The strategy pair compete-compete is a dominated strategy equilibrium. Unless a strong incentive to cooperate exists, such as a federal mandate required by Congress, both states will compete. If both parties were rational, the equilibrium would obviously be for both states to cooperate. One of the most important roles of government is to implement policies where market failures exist; competition among the states is a prime example of a market failure demanding Federal attention.

Unfortunately, under the current political climate where cooperation is practically a curse word and the perception of losing state revenue is political suicide, it is unlikely that such a mandate or bill will ever reach fruition.

Dr. Rolnick has become a highly sought after expert in this field. The evidence is overwhelming; investing in early education provides substantially higher returns than investing in so-called public goods such as stadiums. Some studies suggest that in metropolitan areas the returns to preschool are $16-$1, a huge return on the initial investment. For more information, read this article, "Early Childhood Development: Economic Development with a high public return."

I'll leave you with the concluding paragraph from the article linked above:

"The conventional view of economic development typically includes company headquarters, office towers, entertainment centers, and professional sports stadiums and arenas.[...] The return on investment from early childhood development is extraordinary, resulting in better working public schools, more educated workers and less crime." - Art Rolnick, Rob Grunewald


 

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